Outbound mergers: Tax laws may play spoilsport
In April this year, the ministry of corporate affairs notified relevant provisions of the Companies Act, permitting the outbound merger of an Indian company with a foreign company.
While the move is certainly a step in the right direction, the government would need to tweak the income tax laws if this particular reform is to take flight.
Tax laws at present do not specifically cater to outbound mergers, making it an unattractive proposition from a tax view point.
For example, unlike domestic or inbound mergers there is no specific tax exemption for outbound mergers.
When an Indian company merges into a foreign company, the consequent transfer of the capital assets of the Indian company to the foreign company is technically liable to capital gains tax in India.
Given the fact that the Indian company would cease to exist upon the merger, the tax authorities could attempt to fasten the tax liability onto the foreign company or its shareholders.
Another issue that could arise pertains to shareholder taxation.
Under the income tax law, any consideration (including shares of the amalgamated foreign company) received by the shareholders of the Indian company as a result of an outbound merger would potentially be taxable in India as capital gains.
It is noteworthy that in the case of domestic and inbound mergers, where the consideration received by a shareholder of the amalgamating company is in the form of shares of the amalgamated company, then subject to certain criteria being fulfilled, the receipt of shares as consideration is a tax-neutral event.
In case of an outbound merger, the foreign company could also be confronted with permanent establishment issues in India.
For instance, where the Indian company owns any fixed assets or has any business operations in India, upon the completion of the merger such fixed assets or business of the Indian company would end up being owned/controlled by the foreign company.
Unless the foreign company immediately sells such properties or business, it could under the tax laws be treated as having a permanent establishment in India.
This in turn could expose the foreign company to tax in India at a rate of nearly 44% with respect to any income attributable to such assets/business operations.
Successor tax liabilities are another area that may pose a challenge both for the foreign company and the Indian tax authorities, since the foreign company would be held accountable for tax liabilities of the Indian company for the period prior to the merger.
It is quite plausible that tax liabilities of the Indian company relating to the period prior to the merger may arise well after the merger has been consummated.
Enforcement of tax claims against the foreign company, especially in a scenario where it has no assets/operations left in India, would be problematic.
In such a scenario, one anticipates that the tax authorities may routinely express reservations with respect to any proposed outbound merger before the tribunal examining the scheme or alternatively require that the foreign company provide some form of financial guarantee with respect to future tax claims.
Given the complexities that a taxpayer may currently confront on account of legal, regulatory and tax issues, one anticipates that it may be a while before outbound mergers gain currency in India.
On the tax front, one hopes that the finance minister uses the forthcoming union budget to iron out the creases and ensures that outbound mergers are treated at par with inbound and domestic mergers.
Abhay Sharma is a partner with Shardul Amarchand Mangaldas. The views expressed in this article are those of the author and may not reflect the views of the firm.